EMD star McNamara storms 'last high rate stronghold'

Last month alone saw Argentina’s president seek refuge in a British private jet for fear her official aircraft would be impounded in a debt dispute. Then followed Venezuela’s President Hugo Chavez’s absence from his own swearing in ceremony owing to ill health. Despite all the upheaval, McNamara changed little in the $8.7 billion assets under his watch. The Citywire Euro Stars AAA-rated manager hasn’t held Argentinian debt for over a year due to weak economic fundamentals. Venezuela too has long been off the agenda.

From GAM’s London offices, McNamara instead looks for opportunities in global trade, and Latin America has been a good contributor to performance in his portfolio of local currency debt.

‘When you overlook the kind of Chavez regime extremes, there’s still a very broad political spectrum across Latin America which seems to matter less than the price of a country’s export market,’ says McNamara, who has held an overweight in the region for the past two years.

‘Why asset prices have done so well in the past decade in regimes as diverse as Uruguay, with its moderate socialism, and Mexico and Columbia, which have quite aggressive liberal economics, is all down to commodity prices.

‘We’ve been in a secular bull market and all you’ve needed to do is buy Brazil, Chile and Columbia without thinking too much about which one to go for – in all, credit and currencies have gone through the roof against the euro and the dollar.’

The New Asia?

The characteristics that once underlined the investment choice in Asia are increasingly moving westwards, according to McNamara. The Asian export story, compared to the Latin American one, has taken a huge hit since the financial crisis.

Two of McNamara’s favourite positions in Latin America remain Mexico and Brazil. Brazil leads the region but LatAm’s second largest economy, Mexico, has emerged as a strong competitor to the North American and Asian labour markets.

Towards the end of last year, Mexico’s congress passed radical reforms aimed at boosting corporate cost-efficiency. The approval of controversial labour laws has been viewed as the biggest shake-up of the job market in more than four decades.

Mexico has long been a source of relatively cheap labour and the new pro-business laws are making it easier for companies to exploit this.

‘Chinese internal costs have gone up a lot and at the same time some of the labour reforms that went through in Mexico are bearing fruit and loosening the labour environment,’ says McNamara.

In September Mexico posted its biggest trade surplus in six months. According to McNamara, this ‘was almost unique in emerging markets against weak international demand.’

In Asia, McNamara has held an underweight position for two years. Supported by accommodative monetary policy, the Chinese credit boom is a risk overlooked by many investors in Asia, he says.

‘Since 2008, Asia’s foreign export markets have really suffered and have made up the difference with domestically-driven growth. Across Asia we’ve now got credit as a proportion of GDP at the same levels as before the 1997 Asia crash.

‘The growth numbers will serially disappoint and generally speaking, I don’t think the potential damage that the aggressive round of leverage has had on Asia is really appreciated.’

Investors should also expect China to continue to prioritise growth over fiscal and monetary tightening, he says.

‘Anything that impedes growth is going to be discouraged by authorities there – and that’s not a healthy environment for a bond investor.’

Getting the big picture right

Weakening growth in Asia would be a headwind for commodities and as such also for the Latin American market. However, McNamara believes any fall in demand is likely to be compensated by tentative recoveries in Europe and the US.

‘What’s important is to get the big picture right and we think that even if weaker growth in Asia doesn’t support commodities, then US and European growth will make up the difference.

‘The fiscal cliff is out of the way in the US and all signs show that the housing market is doing ok. In Europe, we don’t see fiscal tightening as bad as last year. We’re not mega bulls on anything but we’re positive on global growth relative to consensus.’

Yet being relatively bullish doesn’t give McNamara confidence that he can return double-digits this year.

‘Last year we had a triple whammy – more carry, potential for capital gains to go lower and the currency effect.’ This year, he says, the carry is less, the potential for prices to rally is less, at a time when currencies are more expensive to start with.

The only exception where McNamara is comfortable to stay long duration is Chile.

The country, according to World Bank figures, is estimated to have around 60% of its workforce paying into a pension scheme (see p30 for an interview with one of the country’s largest pension fund managers). In comparison, employed Mexicans saving for a retirement plan are reckoned to be less than 30%.

‘Chile has a much higher savings society and traditionally had bond yields at around 5-6%, which is where they are today. Mexican rates have come down from double-digits to lower than Chile, where they never have been before.’

Latin America is starting to carry a hefty premium. Mexico, especially, has emerged as a key holding in many emerging market portfolios, including in those run by emerging market equity veteran Mark Mobius, who has tipped it to succeed Brazil as the powerhouse of Latin America.

Valuations have now forced McNamara to reduce duration across the portfolio.

‘I’m sitting in the middle of Mayfair and in the office blocks around me I’m sure that you’ll find another 30 managers or more that are long the Mexican peso. The problem with Mexico right now is that it’s everybody’s favourite.’

No stone unturned

In both absolute return and his long strategies, no-go zones are few and far between for McNamara.

Polled by Citywire last summer, fund selectors voted McNamara’s Julius Baer Local Emerging Bond fund the number one choice for a local currency fund. Much of this popularity is down to its strategy of mitigating volatility and a diversified approach.

The fund can invest in Central Europe, the Middle East and Africa (CEMEA) region, Asia and Latin America and shows a preference for BBB-rated bonds. It is also set up to take advantage of a broad diversification of currencies and favours local currency debt.

Only in 2009 did the fund make an exception to its strategy. When markets were in turmoil and riskier assets out of favour, the fund took hard currency exposure up to 12%.

But this is not to say he’s one to shy away from bolder bets. McNamara held on Venezuelan bonds through the 2007 strike of the country’s state-owned oil and natural gas company (PDVSA).

‘Even at the extremes of the PDVSA action when oil prices were much lower, the Chavez regime paid all of its external debt. Since then the Venezuelan story has slipped into the rogue category that to a lesser extent also categorises Argentina,’ he says.

However, today, McNamara doesn’t hold any Argentinian or Venezuelan exposure. Argentina, he insists, he didn’t buy due to poor economic fundamentals rather than headline risk.

The outcome of the legal battle between Argentina and the creditors of its defaulted debt is, at the time of writing, still unclear and in the appeal stage.

But what is clear is that whatever the outcome it will undoubtedly have repercussions for any country or corporation on the brink of default.

‘The value of especially low-rated bonds is going to be less. As any country drifts towards default, they are going to be aware of this precedent,’ says McNamara.

‘It reduces the desirability of weaker sovereign credits like Venezuela and the Ukraine, where default is more conceivable and where a significant amount of their debt comes under foreign law.

‘Obviously I would prefer that this ruling does not stand. It’s bad for the economy, bad for the market I work in and makes it much more expensive for countries to borrow.’

Revolving door

In order to find value this year, McNamara is looking past the traditionally held emerging markets to fallen angels closer to Europe.

His JB BF Local Emerging fund carried Turkey, Brazil, Hungary, Russia and Mexico as its largest positions into the new year.

‘Where I think we will find value this year is in countries that fell the most after the crisis. Turkey has been an outperformer but I think it’s time to take some chips off the table. It’s clearly not as good as it was.

‘I actually think that there is more value in countries that were hardest hit in 2008 like Romania and Russia. We’ve also seen Russia react positively to foreign investment and open the market out further which also makes us very positive on the rouble.’

With a regional overweight in the Central and Eastern Europe and CEMEA regions, McNamara additionally favours countries such as Poland as a way to diversify away from commodity price risk.

‘These are countries with low-end manufacturing that do well in an environment of moderate recovery in the developed world and controlled commodity prices.’

When an outperforming manager in a relatively high yielding sector has modest expectations even on this year’s outlook, you know that the year ahead is going to be a tough one.

Safety measures

For safety, McNamara says he is buying inflation-linked bonds. This is less due to inflationary concerns but rather because they offer a more conservative instrument in which to diversify.

Safety is costly and McNamara admits that the investment environment will inevitably drag on performance.

‘We are living in a world with few investment opportunities. Ten-year treasuries are yielding less than 2% and central banks are going to continue to pump money into other areas.

‘You’ve got Turkey, Russia and South Africa but really you have fewer and fewer countries that offer double-digit yield.

‘What you can say, especially about Brazil on the currency and bond side, and Latin America as a region, is that it is the last stand of high rates in a low yielding world.’

This article originally appeared in the February 2013 edition of Citywire Global magazine.

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